Assuring
the Price
is Right
Online
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Assuring the price is right online
Be clear on where competition is misplaced:
In 1999, more than 300 Internet companies went
don’t price in a manner that turns core
public. While average revenues were about $18
channels into competitors.
million, average costs were twice that amount,
leading to losses of about $18 million. At first,
investors assumed this was a good thing—that growth
Size up the competition
should be the primary objective, profits could be
First, size up the competition. Analyze your
generated later. But as losses grew worse, investors
economics relative to theirs and understand industry
grew skeptical. Stock prices of e-tailers plummeted:
dynamics. If you determine competitors are
CDnow dropped 44 percent in the second half of
pricing below cost, you need to decide how long
1999; eToys fell 35 percent; Beyond.com, a whopping
they can sustain it. If they have deep pockets—and
72 percent. Even the mighty Amazon lost 25 percent
you do, too—you may have to match their prices,
in the last two months of 1999. Investors demanded
signaling that they can’t win with these tactics and
evidence of a real business model, with real economic
encouraging them to return margins to sane levels.
value. And Buy.com, which built its brand on beating
Or, in a branded industry, differentiate, price sanely
any price on the Web—even if that meant selling
and let the competition give away margin. If
below cost—had to revise its proposition to go public.
competitors can’t sustain the losses, you may let
Then came Christmas 1999. The lesson: too many
them implode and pick up the pieces afterwards.
customers were happy with Internet prices. Almost
Barnes & Noble bought Books.com, a foundering
none were happy with service quality. The choice:
cut-price e-tailer, and now sells online at only three
should e-tailers raise prices to help fund the services
percent below the offline price. Buy.com had to
that customers are now demanding, or simply generate
abandon its zero-margin approach to attract more
bigger losses and hope somehow to survive or be
financing; even with cut-throat pricing it couldn’t
acquired? In a world where competitors are pricing
achieve the scale necessary to survive on advertising
below cost, should a traditional company match
revenues alone.
prices online (creating significant problems for its
offline business), or build a sustainable business
model and wait for its competitors to fall apart?
These are life or death decisions, and many
companies have inadequate experience dealing
with them. Where to start?
At the same time, be clear on where competition
is misplaced: don’t price in a manner that turns
core channels into competitors. Both Levi’s and
Reebok have pulled out of the Internet in part
because direct sales irritated distributors. 3Com Direct
prices its Palm V almost 20 percent above low-price
distributors like eCost.com and Buy.com. It’s not
giving away profits; it’s providing visitors to its site an
expected service—the ability to purchase—but at a
price point that won’t alienate its existing channels.
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
1
Introductory pricing or loss-leading works only where you can hook customers securely
enough to cross-sell higher margin goods or ongoing services. And such a strategy is less
likely to take in an environment where consumers can switch retailers with the click of a
mouse and cherry pick free offers.
Don’t bank on price increases
Next, lead with your true value proposition. Use
the Internet to create profitable customers. It
may seem at first glance that loss-leading dominates
Internet retail. Amazon offers 50 percent off all
introduced a fee, subscribers dropped to 50,000,
and then slowly climbed back to 150,000. Business
Week, Fortune, The Economist, and TheStreet.com all
are grappling with the same dilemma—how to
convert freebies into profitable revenue streams?
bestsellers; CDnow offers 30 percent off recent
Introductory pricing or loss-leading works only
top albums. The Internet does allow consumers
where you can hook customers securely enough to
to spot bargains and change retailers instantly, but
cross-sell higher margin goods or ongoing services.
so far price-based competition remains concentrated
And such a strategy is less likely to take in an
in commodity products like books, music, and
environment where consumers can switch retailers
consumer electronics. Meanwhile, the low-price
with the click of a mouse and cherry pick free
players, like Buy.com, Onsale, and Accompany, are
offers. Witness last year’s fiasco over PC deals with
bleeding losses. Their promise to achieve profits
Internet sign-up. Microworkz of Seattle began
through access to large customer bases is wearing thin.
pitching a computer and Internet service deal for
The fact is, early adopters of a new technology,
like the Internet, are usually less price-sensitive
and more convenience driven. Therefore, cut-price
retailers are probably leaving money on the table.
Penetrating a more typical slice of the population
brings in lower incomes and greater price sensitivity.
Just think of the price trajectories of cell phones,
computers or broadband access—all straight down.
$299 in the spring of 1999. By summer, its chief
executive officer resigned amid customers’ complaints
that they did not receive computers, and the Internet
service provider ended its partnership. New Yorkbased Enchilada.com stopped accepting free orders
for Internet sign up in July, and DirectWeb.com of
New Jersey stopped shipping free PCs in October.
FreeMac.com has promised 1 million free iMacs
but has yet to give one away. It ended its free program
Trials or temporary promotions with built-in
in late November with one million people on its
switching costs are one thing. Witness how AOL
waiting list. Executives involved in such debacles
has grown its 20 million customer base through
blame the problem on scale. The bottom line
offering one month’s free trial, at the end of which
is that companies should invest in great online
customers are reluctant to change their e-mail
services at the outset, and price them accordingly.
addresses. But changing price expectations is
If you plan to raise prices later, then strategically
another. Just ask the online publishers. The Wall
test the waters now. Don’t just hypothesize a
Street Journal signed up 600,000 subscribers for an
pricing strategy—confirm it.
introductory offer of free news online. When it
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
2
Figure 1: Customer reasons for making
Internet purchases
100
Shopping Enjoyment
Product Information
More Enjoyable
Service
80
Product Information
Better Quality
Product Information
Better Service
60
Wider Selection
Percent (Total
Customers)
More Enjoyable
Better Service
Brands/ Products
Convenience
Convenience
40
Brands/ Products Selection
Convenience
20
Lower Prices
Lower Prices
Lower Prices
0
Apparel
Groceries
Consumer Electronics
Source: Bain & Company/ Mainspring Online Retailing Survey (n=2116), December 1999
Bolster your brand
Indeed, bolstering brands through consistent pricing
To get your value proposition right, understand
gives bricks-and-mortar companies a tremendous
what you stand for, and why. The message you
advantage online. The sheer number of e-tailers
send customers online and off should be consistent.
is overwhelming to most consumers. Concerns
Customers know that the Internet cuts costs for
about transaction security and stories of goods
some retailers. If you have a reputation for passing
failing to appear mean that consumers are unsure
on distribution savings to customers, for example
of whom to trust. Many consider brand a key
by selling financial services direct, then you need
purchase criteria. (Figure 1) In response, pure-
to offer discounts online. On the other hand, take
play retailers are spending huge sums on brand
Wal-Mart: its position is “Always Low Prices.” So
building. Internet firms spent about $2 billion on
what would the company be signaling if it went
offline advertising in 1999, and only a handful are
online with even lower prices? Would that suggest
achieving their goal. Today, five percent of sites
to customers that there is “fat” in the offline world
experience 75 percent of hits. That gives street-
and undermine its position? Or consider Neiman
level retailers with trusted brands a head start in
Marcus: it has built a brand around quality and
cyberspace and strong rationale for integrated
service. Competing online on price would only
pricing. Consider Toys “R” Us. It launched its
confuse customers and erode the brand.
defensive Internet play in 1998, a year after the
online leader, eToys, and experienced difficulties.
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
3
By Christmas 1998, Toys “R” Us’s web sales had
Pure plays with brand equity can position themselves
barely blipped. Then the company neglected to
upstream, too. For example, the overall price of books
develop adequate order handling and fulfillment
on the Internet varies 33 percent, and the most
capabilities, generating widespread bad press.
strongly branded online bookseller, Amazon, often
Nonetheless, the company kept its pricing consistent
prices higher than its competitors. Its prices are 3-13
and has closed on eToys fast: the 1999 battle for
percent more than the likes of Kaboombooks, Books
holiday traffic was fiercely fought, with eToys
a Million, and Buy.com—and Amazon still enjoys
emerging only just ahead.
dominant share. By contrast, the market share of the
former Books.com, whose prices were lower than
Amazon’s 99 percent of the time, never exceeded
two percent.1 (Figure 2) Clearly, consumers are
Consistent pricing that bolsters brand
willing to pay for a trusted, consistent brand.
doesn’t mean all customers need to pay
the same price. Rather, companies can use
different selling vehicles and offerings to
reach different types of customers.
Figure 2: Market share vs. relative pricing
99%
100%
80%
80
60
Percent
40
20
2%
1%
Books.com
Amazon.com
0
Amazon.com
Market Share
Books.com
Percent of Time Price was Lower
Source: "Frictionless Commerce? A Comparison of Internet and Conventional Retailers," MIT Sloan School of Management, August 1998.
1Since the study, Books.com has been acquired by Barnes & Noble.
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
4
Segment for premium pricing…
(e.g., Procter & Gamble’s Reflect.com, which by
or bargain hunting
customizing health and beauty products can charge
But consistent pricing that bolsters brand doesn’t
mean all customers need to pay the same price.
Rather, companies can use different selling vehicles
and offerings to reach different types of customers.
salon-like premiums); and third-party endorsements
(e.g., Microsoft’s endorsement of Internet site
hosting service providers), which enhance consumer
trust. Service differentiation and trust in the
brand allows Schwab to charge $29.99 per stock
Some will want top-quality service, speed, ease of
shopping, and rewards—and be willing to pay a
premium. After all, such differentiation requires
transaction—versus $8 at even cheaper discount
brokerages—and still capture 70 percent of the
pool of profits in online trading.
investment. What has Amazon done with the $80to-$250 million it’s gained from its price premium?
Besides building its brand, it prioritized investment
in customer support, product selection, patents to
protect its state-of-the-art “1-Click” shopping
model, and order fulfillment—in short, top-quality
service. Now it’s moving to reduce operating
Such differentiation serves both to justify premiums
and to protect them by effectively erecting switching
costs. What satisfied customer wants the trouble
of reconstituting shopping lists? Rewriting his or
her personal profile? Setting up accounts with
another broker?
losses. And Amazon is not alone. Many others on
the Web are achieving price premiums by building
their brands—including awareness of their sites—
and differentiating their services.
Online grocers invest in tailoring refillable shopping
lists and loyalty rewards. Companies such as Dell
have invested in capabilities that are difficult
to replicate, like superior inventory management
Service differentiation and trust in the
brand allows Schwab to charge $29.99
per stock transaction—versus $8 at even
cheaper discount brokerages—and still
and manufacturing. Other successful examples
capture 70 percent of the pool of profits
of premium-priced service differentiation include
in online trading.
enhanced delivery (e.g., Staples’ next-day delivery
promise); online customer feedback and shopping
assistance (e.g., Amazon’s customer-written book
reviews and purchase suggestions); customization
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
5
But some segments don’t care about speed or service;
Develop a financial vision, not a pipe dream
they want a bargain. The same company offering
So how, in the end, do you know if your online
high, fixed prices to its time-sensitive customers can
pricing strategy is right? How do you know you
offer bargains to price-sensitive customers through
aren’t substituting fantasy for financial vision? So
Internet auctions and other so-called “dynamic
many hot Internet IPOs have missed targets by a
pricing” vehicles. Indeed, the Web has struck a
mile. Fashionmall’s losses have been 17 percent2
revival in dynamic pricing, where vendors adjust
more than expected; Value America’s 1999 profits
prices in real time, based on observed, rather than
are expected to come in 33 percent below nine-
estimated, supply and demand, as in the old farmer’s
month-old forecasts. This, despite meeting revenue
market or village bazaar. Today, these dynamic models
targets. The list goes on. One has to ask whether
most often are used for distressed or perishable
these companies truly did their homework. Did they
inventory, like clearance goods or airline tickets.
include in their business models the fundamentals of
These models not only allow retailers to perfectly
intelligent financial planning? Did they assess
price differentiate, but also allow consumers the
conversion rates of browsers to shoppers? Retention
thrill of the hunt. (Figure 3) The future sees firms
rates of customers? The lifetime value of loyal
increasingly using the Web to segment pricing
customers? And did they understand what pricing
according to different customer needs.
strategy would correctly signal their value proposition
Figure 3: Dynamic pricing models
Overview
Examples
Ascending
Auctions
Goods are allocated through a bidding process that determines which
customers are willing to pay the most.
• eBay
• Onsale
• uBid
Descending
Auctions
Goods are allocated to customers on a first-come, first-served basis as
the price declines over a given period, or until the supply is exhausted.
• Basement.com
Reverse
Auctions
Sellers, rather than buyers, compete to offer the lowest price for goods.
• eWanted
• FreeMarkets
• Nextag
Customers make an offer to a seller or group of sellers for goods
based on their estimate of the seller's lowest acceptable price.
• Priceline
• Expedia (on hotel
reservations only)
Sellers offer tiered pricing to ad hoc buying cooperatives in which the
unit price declines as the quantity purchased increases.
• Accompany
• ActBig
• Mercata
Name Your
Own Price
Demand
Aggregators
Source: Bain & Company/ Mainspring Analysis
2Source: Gruntal & Co, 5/1999
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
6
and attract the right customers to begin with? Online
success. Then ask, and answer, the full gamut of
businesses, like bricks-and-mortar companies, need
hard questions: how much should you invest in
to do the research—to understand their customers’
price reductions versus service versus marketing
needs and competitors’ cost structures relative to
versus capabilities? Who are your most attractive
their own—and price for profitability.
customers and what is the right pricing model to
After all, appropriate pricing is fundamental to getting
go after them?
your marketing mix right in any business. The
The IRS distinguishes between a “business” and a
Internet is a new channel—not a whole new ballgame.
“hobby” based on whether the activity in question is
For some companies, low prices will be the right
designed to be profitable and achieves its design
answer. But any company can drive customer traffic
within a few years. From the numbers posted on last
with unsustainable price cuts—just ask Caldor, Crazy
year’s Internet IPOs, too many online operators are
Eddie, 47th Street Photo, or any other defunct retailer.
making a hobby of bad business. To be successful,
Popular Internet metrics like “traffic,” “click-throughs,”
you need the right pricing strategy—or you may go
“eyeballs,” and just plain revenues are wrong-
out of business altogether.
minded. Look instead at the pricing strategies of
retailers who are creating and keeping profitable,
lifetime customers—The Gap, Dell—to measure
Any company can drive customer traffic with unsustainable price cuts—just ask
Caldor, Crazy Eddie, 47th Street Photo, or any other defunct retailer. Popular
Internet metrics like “traffic,” “click-throughs,” “eyeballs,” and just plain revenues
are wrong-minded. Look instead at the pricing strategies of retailers who are creating
and keeping profitable, lifetime customers—The Gap, Dell—to measure success.
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
7
Bain & Company:
Mainspring
Strategy for sustainable results
eStrategy Consulting
Bain is one of the world's leading global business
Mainspring is the leading eStrategy consulting
consulting firms. Its 2,500 professionals serve major
firm that focuses exclusively on developing
multinationals and other organizations through an
actionable Internet strategies. It enables Fortune
integrated network of 26 offices in 18 countries.
1000 companies to protect, evolve, and transform
Its fact-based, "outside-in" approach is unique, and
their business for sustained competitive advantage
its immense experience base, developed over 27
by offering an integrated process of business,
years, covers a complete range of critical business
customer, and technology strategy planning. Its
issues in every economic sector. Bain's entire
proprietary process hinges on the following
approach is based on two guiding principles:
activities to help guide clients effectively through
1) working in true collaboration with clients to
eStrategy development:
craft and implement customized strategies that
• Building the Business Model
yield significant, measurable, and sustainable
• Creating the Customer Experience
results, and
• Defining the Solution Architecture
2) developing processes that strengthen a client's
• Commercializing the Business Plan
organization and create lasting competitive
Working with Mainspring, companies identify,
advantage. The firm gauges its success solely
define, and formulate a portfolio of strategic
by its clients' achievements.
Internet initiatives that are customized for their
Bain & Company's global e-commerce practice
helps businesses achieve outstanding results in the
business and designed to create sustainable
competitive advantage.
new economy. We work with traditional companies
Mainspring’s core services include eStrategy
to launch and manage online operations, and with
Consulting, eStrategy Direct, and the eStrategy
pre-IPO clients to hone business models and accelerate
Executive Council. These services are provided
to market. We also work with entrepreneurs to
to companies in the financial services; retail and
incubate new ideas into viable businesses, in some
consumer goods; technology, communications, and
cases taking equity stakes through our bainlab
media; and manufacturing industries. Mainspring
subsidiary. Our e-commerce practice professionals
was founded in 1996 and has offices in Cambridge,
work around the globe in every major industry.
Massachusetts and New York City.
B a i n & C o m p a n y, I n c .
Assuring the Price is Right Online
8
By Darrell Rigby and Sharad
Rastogi of Bain & Company;
Julian Chu of Mainspring
BAIN & COMPANY, INC.
MAINSPRING
Two Copley Place
One Main Street
Boston, Massachusetts 02116
Cambridge, Massachusetts 02142
Tel:
Tel:
(617) 572 2000
(617) 588 2300
Fax: (617) 572 2427
Fax: (617) 588 2305
www.bain.com
www.mainspring.com
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